How Life Insurance Policies Work
Life insurance is a critical part of any financial life plan. If you are considering it, you might wonder how life insurance policies work and what the big deal is about? Well, let's take a look.
A life insurance policy is a financial tool used to create a pool of money once you pass on to meet your maker. You enter into a policy in which you agree to pay money for what is known as a death benefit. This benefit is paid out to the beneficiaries of the policy which you select. The policy can accumulate cash within it or it can simply be designed to make a payment when you die. Confused yet? Let's look at an example.
Let's assume I am married with a child and am 30 years old. I need to buy life insurance to protect my wife and child in case I suddenly pass away. I decided to buy a term life insurance policy. I get a $500,000 policy and pay $150 a month for it. I name my wife as the beneficiary of the policy. The policy is good for 20 years. As long as I make the payments, my wife will receive a lump sum payment of $500,000 if I die in a car crash or what have you during the period of the policy. What happens if the full 20 years run? Well, then I'll need to buy a new policy.
A life insurance policy is also a financial bet by an insurance company. The company is betting it can recover enough in premiums compared to how much it pays out on various policies. In the example above, it is betting that the 20 year period will run before you pass away and it has to pay out the $500,000. This is why payments on insurance policies are much less the younger you are.
Paying a premium of $150 might seem like a great deal for life insurance. Well, it is. That being said, the life insurance companies spend a lot of money and time calculating the chances of a loss over the entire population. Remember, people get killed in accidents and what have you all the time. When all the factors and population data are taken into account, the life insurance company knows it will probably do pretty well in the long run.
This pretty much covers how life insurance policies work. That being said, there are a lot of different types of policies that you can use as part of your overall financial planning. Make sure to investigate them.